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With Treasury yields recently slumping and amid all the talk about the adverse impact the Delta variant of the coronavirus could have on markets, one would think Armageddon arrived for the reflation trade and cyclical stocks.
Even with all the recent hysteria to that effect, the S&P 500 Value Index is higher by 1.22% over the past month. This is the lay of the land today. There has been some retrenchment in value stocks, but there's not a consensus that cyclicals and value names are done for.
In fact, prevailing wisdom right now goes along the lines of value having more gas left in the tank while acknowledging the trade has a shelflife. Of course, as has been widely documented, timing expiration of factor leadership is difficult and arguably not worth the trouble. That's all the more important when remember it's been while since value was a legitimate leader and the current run of value leadership is younger by historical standards.
Indeed, there's been business cycle compression, but even if cyclical stocks don't outperform for as long as they historically do coming out of recessions, there's still significant runway for riskier fare to deliver for clients. It's simply on advisors to impart upon clients that cyclical leadership is finite and will expire at some point.
Riding the Wave
Not to get deep into the weeds here, but the concept of sine wave analysis can help advisors gauge the intensity of a cyclical rally and perhaps get a sense for how much further it can run. Essentially, sine waves show economic recovery and expansion in the middle with recessions on both sides.
“From my lens, it took us about a year to complete the first quarter (25%) of one sine wave. In the second quarter (or next 25%) of the same wave, I think we should see decelerating but positive returns on cyclicals over the coming 12 months,” says Invesco Senior Investment Strategist Talley Leger. “More importantly, there appear to have been two to three of these sine waves over the course of a given business cycle, bookended by two economic recessions. If that’s right, I don’t think investors can easily conclude that the bulk of the move in cyclicals is behind them.”
One thing for advisors to bear in mind is that the longer cyclical stocks remain in favor, the likelihood increases that market participants will move toward the higher quality names in this arena. That transition is already underway or quite close to getting there, which is to say the riskier junkier fare that led the initial cyclical rally could fall out of favor but that doesn't mean cyclical value itself will be broadly discarded.
An efficient way of conveying this to clients is that value may run further, but quality is going to carry the day as economic growth becomes more subdued.
Don't Fret About Growth
Something else advisors well know is that growth stocks worked very, very well for than a decade and clients became quite fond of that exposure. Today, they might be wondering when those go-go days will return.
Good news: It's a matter of “when” not “if” growth returns to the limelight.
“Within cyclicals, the growth style of investing and technology stocks seem to be benefiting tactically from the very same China-related easing of bond yields,” adds Invesco's Leger. “Beyond that, I believe there’s a window of opportunity for the value style of investing, but I’ve always considered it as a finite 'recovery' trade. Ultimately, I think growth stocks should regain durable leadership as economic gravity sets in and the world settles back into a more sustainable pace of output.”
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